How Blockchain Offers an Answer to Banks’ KYC and AML Issues

In September, lawyers for Denmark’s largest bank, Danske Bank, revealed that between 2007 and 2015, over 200 billion euros were illegally laundered through a branch in Estonia. The case amounts to a major blow for KYC (Know Your Customer) and AML (Anti-Money Laundering) procedures — with the added dimension that several employees are believed to have colluded in the process.

This may be something of an extreme example. However, many of the world’s leading banks have been fined on AML issues over the last decade. In fact, it is estimated that fines have reached US$26bn over that period.

Globally, it’s clear that banks’ efforts to evolve measures to detect and prevent criminal behavior have enjoyed mixed success. Banks’ KYC solutions have generally been reactive — built in response to large fines or broad regulatory interventions. They have been layered onto legacy business models and systems, with an emphasis on quick implementation.

This is understandable, given the risks; however the issue is that most customers are honest individuals and companies trying to conduct legitimate business but who are now increasingly subject to onerous and constant checks. The result is, at best, an unsatisfactory customer experience, while at worst law-abiding SMEs and other customers are deprived of credit and banking services in certain countries or industries. If it also meant a visible reduction in money-laundering or financial crime then it would be easy to argue that the ends justify the means. However, the reality — besides significantly increased costs for the banking industry — is that financial institutions are struggling to keep pace with increasingly sophisticated detection avoidance systems. As banks and regulators have started to realise, there is a solution: blockchain.

On the blockchain — because of the way information is shared on a distributed ledger system, an archive of records, if you will — any and all information placed on it is secure, transparent and immutable. Here is how:

A customer’s background, financial records, source of income, wealth and assets can only be placed on a blockchain once there is consensus across the whole network that all the information is accurate.

It is extremely difficult for any false information to be submitted for this reason, and because each data entry is cryptographically hashed, it is very difficult to tamper with the information once it is verified and put on the blockchain.

In the last 12 months, there has been progress in terms of how regulators are thinking through how to encourage the use of blockchain technologies.

Blockchain is not the regulatory minefield of bureaucratic or journalistic imagination; rather, it can be an asset in the regulatory armory.

Indeed, blockchain technology mitigates data ambiguity and reduces the potential for fraud. If all banks are on the blockchain, KYC and AML data can be shared across financial institutions in a manner that is secure, transparent and seamless.

Immutability is a defining aspect of blockchain and one that paves the way for new levels of trust. With each unique KYC profile, there can be an auditable trail of activity that no-one is able to change or corrupt — not even bank employees (as is reported to have happened at Danske Bank). Moreover, the decentralized nature of distributed ledger technology — even in a private network — removes the risks associated with having single, central points of failure, thereby protecting data from hacks and other cyber-attacks.

For banks, the benefits are myriad: greater security, consistency and operational efficiency; increased interoperability between institutions; an end to costly, time-consuming duplication of data-gathering, data-processing and data verification; and, ultimately, enhanced regulatory compliance. For regulators, meanwhile, blockchain makes data on customer activity more visible and more reliable. And for the hard-pressed customer, blockchain-based KYC systems augur reduced on-boarding times and increased confidence in financial service providers.

If we want to avoid scandals in banking that are borne of poor implementation of regulations — or worse, deliberate criminal activity — then blockchain systems provide an answer that governments and regulators would be unwise to ignore.